That has led to one-month USD/JPY risk reversals moving into positive territory for the first time since March 2004, signalling that demand in the options market is increasing for USD/JPY upside protection, according to Bank of Tokyo-Mitsubishi UFJ. So, is it a signal that dollar yen is set to make a substantial break higher, given the rarity of such an event?
No, says one option trader at a European bank. The move needs to be put into context, he says. Risk reversals are determined by supply and demand, not just sentiment. The trader notes that there has been constant demand throughout the year for topside strikes, particularly in the shorter dates, because the threat of the Bank of Japan intervening has always been prevalent.
With this in mind, the limited prospect of any sizeable downside in USDJPY has seen a consistent demand for downside one touches and reverse knock-out structures, which now means they’re selling at extremely discounted levels. For instance, one-month 75.00 strike one-touch option trades are being priced 5% to 6% lower than the theoretical price.
What this adds up to is a lot of supply on the downside and a lot of demand on the topside, which has meant that risk reversals are now a better bid for higher strikes. That isn’t just isolated to the short dates now, either, says another options trader. Longer-dated topside buyers have also started to emerge in recent days.
“I don’t necessarily think it reflects any sort of sentiment for people thinking there’s going to be a significant move up, it’s more a case of a lot RKOs and barriers knocking around, and the threat of intervention,” says the head option trader of the European bank. “If anything, client activity has been paying market makers for topside gamma and it’s really just that both ends [topside and downside] of the market having been pulling at the risk reversal.”
| USDJPY risk-reversals turn positive |
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| Source: Bloomberg |